The Reserve Bank released their bi-annual Financial Stability Review (FSR) earlier today. From a housing market perspective it makes for very interesting reading with the RBA noting that ‘the composition of housing and mortgage markets is becoming unbalanced, with new lending to investors being out of proportion to rental housing’s share of the housing stock.’ The RBA also states, ‘The Bank is discussing with APRA, and other members of the Council of Financial Regulators, additional steps that might be taken to reinforce sound lending practices, particularly for lending to investors.’
The FSR notes that household risk appetite continues to rise with households more willing to take on debt. Of course, with interest rates so low and subsequently both deposit and mortgage rates so low, there is little benefit in keeping money in a savings account so investors are turning their attention to the housing market. The FSR does highlight that the growth in home values is within the larger cities (Sydney and Melbourne). Further, the FSR notes, ‘The apparent increase in the use of interest-only loans by both owner-occupiers and investors might also be consistent with increasingly speculative motives behind current housing demand.’ You may recall that APRA data showed a record high 43.2% of new loans over the June 2014 quarter were interest-only, up from 39.4% the previous quarter.
The RBA notes that excess investor demand can exacerbate the housing price cycle and increase the potential for prices to fall later. They note that these risks are macroeconomic in nature rather than direct risks to financial institutions. While this may be true, with most investors borrowing from financial institutions, were these investors in a position where they had no choice but to sell at a time in which prices were falling, the risk to the banking sector of loss given default would also likely rise.
The document also notes that the willingness of households to take on more debt is resulting in a rise in the debt-to-income ratio. It notes that although it is up a little over the past 6 months, it is still in its range of the past 8 years at around 150%. It notes that this ratio is historically high and any increase in household indebtedness would be taking place from an already high base. What this commentary fails to note is that the last update to this data was in March 2014 and at that time, the housing debt-to-income ratio rose to a record high 135.8%. With investment activity and home values continuing to rise since March, this ratio is now likely to be even higher.
Although household debt levels are high, the document notes that the aggregate mortgage buffer (balances in mortgage offset and redraw facilities) has risen to around 15% of outstanding balances, which is equivalent to more than 2 years of scheduled repayments at current interest rates. Focussing specifically on the investor cohort of the housing market, the RBA notes that the momentum in investor activity has been concentrated in Sydney (and to a lesser extent) Melbourne.
In New South Wales, investor housing loan approvals are almost 90% higher than they were 2 years ago and in Melbourne they are 50% higher over the same period. As a share of all housing finance commitments nationally they are back around previous peaks. At the same time the level of owner occupier demand has slowed over the past 6 months. The document notes that, ‘Strong investor demand can be a sign of speculative excess, with the risk that additional speculative demand can amplify the cycle in housing prices and increase the potential for prices to fall later.
This is particularly the case if that demand is largely based on unrealistic expectations of future price growth, perhaps extrapolated from recent experience.’ In simple terms that means that too much lending to investors is potentially risky for the market and may result in price falls later, particularly if investors are entering the market expecting current price growth to continue. You only have to look at Sydney as an example. The last time investor activity in New South Wales spiked to similar (albeit lower) levels to those currently, home values in Sydney began to fall and took 5.5 years to surpass their previous peak.
The report also notes that an increase in investor speculation can also potentially lead to an oversupply of new housing supply. The report notes that we are a long way from this occurring however, there are certain pockets where this is a risk, most notably inner city unit markets in Melbourne. The secondary risk here is that if there were too many smaller investment units built, whilst they may initially sell off-the-plan they might be much more difficult to sell in the secondary market.
The FSR notes ‘Despite the activity and housing price inflation in the Sydney and Melbourne property markets, rental yields have not declined to a significant extent and vacancy rates in these cities remain fairly low However, rental yields may come under pressure if the momentum in housing price inflation continues. Households should therefore be mindful of the risks when making investment property decisions in these conditions.’ This is another statement that is somewhat difficult to reconcile. The RBA has correctly pointed out that price growth and investment activity is strongest in Sydney in Melbourne.
In these two cities, rental yields have fallen over the past year. In Sydney, gross rental yields were 4.2% a year ago and in Melbourne they were 3.6%, across these cities they are currently recorded at 3.8% and 3.3% respectively. RP Data has been tracking yields since December 1995, the lowest they have been over that time in Sydney were 3.5% and they are currently at a record low in Melbourne.
Overall it is important to note that the RBA is highlighting some growing risks in the residential housing market, specifically within Sydney and Melbourne. Note that some of these risks were highlighted six months ago in the previous FSR and these risks have increased since that time. It is interesting to note that the RBA has stated they are in discussions with APRA, and other members of the Council of Financial Regulators to see how they can reinforce sound lending practices. This suggests that Australian regulators may be seriously considering the introduction of macroprudential tools which place limits on higher risk lending.
If the New Zealand experience is anything to go by (where the RBNZ applied LVR limits on the lending sector), the introduction of macroprudential ‘speed humps’ are likely to have the effect of slowing housing market conditions and speculative demand, however the New Zealand policies were also accompanied by rising interest rates which arguably had a more substantial effect on the market slowdown.